Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Objective
The following discussion provides an analysis of the Company’s financial condition, cash flows and results of operations from management’s perspective and should be read in conjunction with “Selected Consolidated Financial Data” and the consolidated financial statements and related notes included in this report. Our objective is to also provide discussion of events and uncertainties known to management that are reasonably likely to cause reported financial information not to be indicative of future operating results or of future financial condition and to offer information that provides understanding of our financial condition, cash flows and results of operations.
Overview
Innovative Solutions and Support, Inc. (the “Company,” “IS&S”, “we” or “us”) was incorporated in Pennsylvania on February 12, 1988. The Company operates in one business segment as a systems integrator that designs, develops, manufactures, sells, and services, air data equipment, engine display systems, standby equipment, primary flight guidance, autothrottles and cockpit display systems for retrofit applications and original equipment manufacturers (“OEMs”). The Company supplies integrated Flight Management Systems (“FMS”), Flat Panel Display Systems (“FPDS”), FPDS with Autothrottle, air data equipment, Integrated Standby Units (“ISU”), ISU with Autothrottle and advanced Global Positioning System (“GPS”) receivers that enable reduced carbon footprint navigation.
The Company has continued to position itself as a system integrator, which provides the Company with the capability and potential to generate more substantive orders over a broader product base. This strategy, as both a manufacturer and integrator, is designed to leverage the latest technologies developed for the computer and telecommunications industries into advanced and cost-effective solutions for the general aviation, commercial air transport, United States Department of Defense (“DoD”)/governmental, and foreign military markets. This approach, combined with the Company’s industry experience, is designed to enable IS&S to develop high-quality products and systems, to reduce product time to market and to achieve cost advantages over products offered by its competitors.
The Company sells to both the OEM and the retrofit markets. Customers include various OEMs, commercial air transport carriers and corporate/general aviation companies, DoD and its commercial contractors, aircraft operators, aircraft modification centers, government agencies, and foreign militaries. Occasionally, IS&S sells its products directly to DoD; however, the Company sells its products primarily to commercial customers for end use in DoD programs. Sales to defense contractors are generally made on commercial terms, although some of the termination and other provisions of government contracts are applicable to these contracts. The Company’s retrofit projects are generally pursuant to either a direct contract with a customer or a subcontract with a general contractor to a customer (including government agencies).
Cost of sales related to product sales comprises material, components and third-party avionics purchased from suppliers, direct labor, and overhead costs. Many of the components are standard, although certain parts are manufactured to meet IS&S specifications. The overhead portion of cost of sales primarily comprises salaries and benefits, building occupancy costs, supplies, and outside service costs related to production, purchasing, material control, and quality control. Cost of sales includes warranty costs.
Cost of sales related to Engineering Development Contracts (“EDC”) sales comprises engineering labor, consulting services, and other costs associated with specific design and development projects. These costs are incurred pursuant to contractual arrangements and are accounted for typically as contract costs within cost of sales, with the reimbursement accounted for as a sale in accordance with the percentage-of-completion method or completed contract method of accounting. Company funded research and development (“R&D”) expenditures relate to internally-funded efforts for the development of new products and the improvement of existing products. These costs are expensed as incurred and reported as R&D expenses. The Company intends to continue investing in the development of new products that complement current product offerings and to expense associated R&D costs as they are incurred.
Selling, general and administrative expenses consist of sales, marketing, business development, professional services, salaries and benefits for executive and administrative personnel, facility costs, recruiting, legal, accounting and other general corporate expenses.
IS&S sells its products to agencies of the United States and foreign governments, aircraft operators, aircraft modification centers, and OEMs. Customers have been and may continue to be affected by changes in economic conditions both in the United States and abroad. Such changes may cause customers to curtail or delay their spending on both new and existing aircraft. Factors that can impact
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general economic conditions and the level of spending by customers include, but are not limited to, the impact of the ongoing COVID-19 pandemic, general levels of consumer spending, increases in fuel and energy costs, conditions in the real estate and mortgage markets, labor and healthcare costs, access to credit, consumer confidence, and other macroeconomic factors that affect spending behavior. Furthermore, spending by government agencies may be reduced in the future if tax revenues decline. If customers curtail or delay their spending or are forced to declare bankruptcy or liquidate their operations because of adverse economic conditions, the Company’s revenues and results of operations would be affected adversely. For example, earlier in the 2020 fiscal year, certain of the Company’s customers temporarily suspended product deliveries as a result of the COVID-19 pandemic, and while these deliveries subsequently resumed, there is a possibility that the COVID-19 pandemic will result in other suspensions, delays or order cancellations by the Company’s customers or suppliers.
In particular, the ongoing COVID-19 pandemic is a significant event, driver of market trends, and source of uncertainty that may ultimately have a direct or indirect material impact on the Company’s business, financial position, liquidity, or ability to service customers or maintain critical operations. In direct response to the COVID-19 pandemic, the Company has taken specific actions to seek to ensure the safety of its employees, including temperature monitoring, frequent sanitization of workspaces, observance of social distancing protocols, and other increased safety measures.
Results of Operations
The following table sets forth statements of operations data expressed as a percentage of total net sales for the fiscal years indicated:
Twelve Months Ending September 30,
Net sales:
2021
2020
2019
Product
98.8
%
96.3
%
92.0
%
Engineering development contracts
1.2
%
3.7
%
8.0
%
Total net sales
100.0
%
100.0
%
100.0
%
Cost of sales:
Product
44.2
%
44.3
%
40.1
%
Engineering development contracts
0.3
%
1.0
%
3.6
%
Total cost of sales
44.5
%
45.3
%
43.7
%
Gross profit
55.5
%
54.7
%
56.3
%
Operating expenses:
Research and development
11.4
%
13.7
%
14.2
%
Selling, general and administrative
27.1
%
28.2
%
33.4
%
Total operating expenses
38.5
%
41.9
%
47.6
%
Operating income
17.0
%
12.8
%
8.7
%
Interest income
0.0
%
0.7
%
1.4
%
Other income
0.3
%
0.3
%
0.4
%
Income before income taxes
17.3
%
13.8
%
10.5
%
Income tax (benefit) expense
(4.7)
%
(1.3)
%
0.0
%
Net income
22.0
%
15.1
%
10.5
%
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Fiscal Year Ended September 30, 2021 Compared to Fiscal Year Ended September 30, 2020
Net sales. Net sales for fiscal 2021 increased $1.4 million, or 6.7%, to $23.0 million from $21.6 million for fiscal 2020. For fiscal 2021, product sales increased $1.9 million and EDC sales decreased $0.5 million, in each case, compared to fiscal 2020. This increase in product sales primarily reflects increased shipments for OEM programs to general aviation customers and displays for retrofit programs to commercial transport customers. These increases were partially offset by reduced shipments under the U.S. Navy F-5 production contract and displays for retrofit programs to other military customers compared to fiscal 2020. The decrease in EDC sales was primarily the result of the completion of a modification contract with the U.S. Navy in 2020.
Cost of sales . Cost of sales was $10.3 million or 44.5% of net sales, for fiscal 2021 compared to $9.8 million, or 45.3% of net sales, in fiscal 2020. The increase in cost of sales was primarily the result of an increase in product sales volume. The Company’s overall gross margin in fiscal 2021 was 55.5% compared to 54.7% in fiscal 2020. The fiscal 2021 gross margin percentage increase was attributable to product mix as well as the favorable leverage achieved by the growth in revenues.
Research and development . R&D expense was $2.6 million for fiscal 2021 and $3.0 million for fiscal 2020. R&D expense decreased to 11.4% of net sales in fiscal 2021 compared to 13.7% of net sales in fiscal 2020. This decrease in R&D expense was primarily the result of a decrease in third party costs related to STC certifications offset by an increase in payroll and payroll related benefits.
Selling, general, and administrative (“SG&A”) . SG&A expense increased $0.2 million or 2.6% to $6.3 million or 27.2% of net sales, for fiscal 2021 from $6.1 million, or 28.2%, for fiscal 2020. The increase in SG&A expense was primarily the result of an increase in employee stock compensation, payroll and payroll related benefits.
Interest income, net. Net interest income of $1,234 in fiscal 2021 decreased by $153,716 as compared to fiscal 2020 interest income of $154,950. The decrease in interest income was primarily the result of decreased cash balance and lower interest rates in fiscal 2021 as compared to fiscal 2020.
Other income. Other income is primarily composed of royalties earned and increased by $14,409, to $74,906 in fiscal 2021 from $60,497 in fiscal 2020.
Income taxes. Income tax benefit for the fiscal 2021 was $1,087,783 as compared to income tax benefit of $308,882 for fiscal 2020. The effective tax rate benefit for fiscal 2021 was 27.4% and differs from the statutory rate primarily due to the release of the valuation allowance for all federal and state deferred tax assets with the exception of certain state net operating losses for jurisdictions in which the Company does not believe these net operating losses are more likely than not to be realized. This release both increased the deferred tax asset and removed the valuation allowance.
Net income. As a result of the factors described above, the Company’s net income for fiscal 2021 was $5.1 million compared to net income of $3.3 million for fiscal 2020. On a fully diluted basis, net income per share was $0.29 for fiscal 2021, compared to a net income of $0.19 per share for fiscal 2020.
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Fiscal Year Ended September 30, 2020 Compared to Fiscal Year Ended September 30, 2019
Net sales. Net sales for fiscal 2020 increased $4.0 million, or 22.9%, to $21.6 million from $17.6 million for fiscal 2019. For fiscal 2020, product sales increased $4.6 million and EDC sales decreased $0.6 million, in each case, compared to fiscal 2019. This increase in product sales primarily reflects increased shipments for OEM programs to general aviation customers, shipments under the U.S. Navy F-5 production contract and increased shipments of displays for retrofit programs to other military customers. These increases were partially offset by reduced shipments of displays for retrofit programs to commercial transport customers compared to fiscal 2019. The decrease in EDC sales was primarily the result of the completion of a development contract for a new air data computer for the U.S. Navy F-5 aircraft and the completion of a development contract in 2019 for a foreign customer on the P-3 aircraft.,
Cost of sales . Cost of sales was $9.8 million or 45.3% of net sales, for fiscal 2020 compared to $7.7 million, or 43.7% of net sales, in fiscal 2019. The increase in cost of sales was primarily the result of an increase in product sales volume. The Company’s overall gross margin in fiscal 2020 was 54.7% compared to 56.3% in fiscal 2019. The fiscal 2020 gross margin percentage decrease reflects increased warranty costs and material costs which was partially offset by an increase in gross margin on EDC programs to 71.5% in fiscal 2020 as compared to 54.7% in fiscal 2019.
Research and development . R&D expense was $3.0 million for fiscal 2020 and $2.5 million for fiscal 2019. R&D expense decreased to 13.7% of net sales in fiscal 2020 compared to 14.2% of net sales in fiscal 2019. R&D expense in fiscal 2020 was $0.5 million greater than fiscal 2019. This increase in R&D expense resulted primarily from increased personnel, related benefits and the reduction of EDC contract activity whose costs are reflected in cost of sales rather than R&D expense.
Selling, general, and administrative (“SG&A”) . SG&A expense increased $0.2 million or 3.8% to $6.1 million or 28.2% of net sales, for fiscal 2020 from $5.9 million, or 33.4%, for fiscal 2019. The increase in SG&A expense was primarily the result of increased personnel costs and related benefits.
Interest income, net. Net interest income of $154,950 in fiscal 2020 decreased by $94,670 as compared to fiscal 2019 interest income of $249,620. The decrease in interest income was primarily the result of lower interest rates in fiscal 2020 as compared to fiscal 2019.
Other income. Other income is primarily composed of royalties earned and decreased by $13,240, to $60,497 in fiscal 2020 from $73,737 in fiscal 2019.
Income taxes. Income tax benefit for the fiscal 2020 was $308,882 as compared to income tax expense of $1,805 for fiscal 2019. The effective tax rate benefit for fiscal 2020 was 10.43% and differs from the statutory rate due to the passing of the CARES Act on March 27, 2020 which allowed for the carryback of the 2018 net operating loss (“NOL”) to fiscal 2017 and fiscal 2016.
Net income. As a result of the factors described above, the Company’s net income for fiscal 2020 was $3.3 million compared to net income of $1.9 million for fiscal 2019. On a fully diluted basis, net income per share was $0.19 for fiscal 2020, compared to a net income of $0.11 per share for fiscal 2019.
Liquidity and Capital Resources
The following table highlights key financial measurements of the Company:
September 30,
September 30,
2021
2020
Cash and cash equivalents
$
8,265,606
$
12,603,967
Restricted cash (1)
$
—
$
11,180,900
Accounts receivable
$
4,046,337
$
4,369,111
Current assets
$
17,690,411
$
33,120,422
Current liabilities
$
2,472,239
$
13,647,117
Contract liability
$
417,504
$
313,365
Other non-current liabilities (2)
$
28,680
$
129,689
Quick ratio (3)
4.98
1.24
Current ratio (4)
7.16
2.43
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Twelve Months Ended September 30,
2021
2020
2019
Cash flow activities:
Net cash provided by operating activities
$
4,592,499
$
2,192,167
$
2,107,398
Net cash (used in) investing activities
(340,678)
(118,797)
(81,281)
Net cash (used in) financing activities
(19,771,082)
(705,333)
—
(1) Restricted cash in fiscal year 2020 represents the payment amount for a special cash dividend paid on October 1, 2020
(2) Excludes contract liability
(3) Calculated as: the sum of cash and cash equivalents plus accounts receivable, net, divided by current liabilities
(4) Calculated as: current assets divided by current liabilities
The Company’s principal source of liquidity has been cash flows from current year operations and cash accumulated from prior years’ operations. Cash is used principally to finance inventory, accounts receivable, contract assets, and payroll. Apart from what has been disclosed above, management is not aware of any trends, events or uncertainties that have had or are likely to have a material impact on our liquidity, financial condition and capital resources.
On September 4, 2020, the Company’s Board of Directors declared a special cash dividend in the amount of $0.65 per share, payable on October 1, 2020 to shareholders of record as of the close of business on September 15, 2020. The total dividend payment was approximately $11.2 million and is included in restricted cash on the accompanying consolidated balance sheets.
On December 10, 2020, the Company’s Board of Directors declared a special cash dividend in the amount of $0.50 per share, payable on December 30, 2020 to shareholders of record as of the close of business on December 21, 2020. The total dividend payment was approximately $8.6 million.
The Company did not pay dividends in fiscal 2019. The declaration and payment of any dividend in the future will be at the discretion of the Company’s Board of Directors.
The ongoing COVID-19 pandemic is a significant event, driver of market trends, and source of uncertainty that may have a material impact on the Company’s liquidity, financial condition, capital resources, cash flows or operating results. In direct response to the COVID-19 pandemic, the Company has taken specific actions to seek to ensure the safety of its employees, including temperature monitoring, frequent sanitization of workspaces, observance of social distancing protocols, and other increased safety measures.
Operating Activities
The Company generated $4.6 million of cash in operating activities during fiscal 2021 as compared to cash generated of $2.2 million during fiscal 2020. The cash generated by operating activities for the year ended September 30, 2021 was primarily generated by net income of $5.1 million, depreciation and amortization of $0.4 million and a decrease in accounts receivable of $0.3 million, partially offset by an increase in deferred income tax assets of $1.2 million.
The Company generated $2.2 million of cash in operating activities during fiscal 2020 as compared to cash generated of $2.1 million during fiscal 2019. The cash generated by operating activities for the year ended September 30, 2020 was primarily generated by net income of $3.3 million, depreciation and amortization of $0.4 million and an increase in both contract liability of $0.3 million and accrued expenses of $0.2 million, partially offset by an increase in accounts receivable of $2.0 million.
Investing Activities
Cash used in investing activities was $0.3 million for fiscal year 2021 and consisted of spending for manufacturing facility and laboratory test equipment. The Company plans to continue investing in capital equipment to support engineering development efforts and operations.
Cash used in investing activities was $0.1 million for fiscal year 2020 and consisted of spending for production equipment and laboratory test equipment.
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Financing Activities
Cash used by financing activities was $19.8 million for fiscal year 2021 and consisted primarily of dividends paid. Cash used by financing activities was $0.7 million for fiscal year 2020 and consisted of tax withholding payments related to an employee’s cashless exercise of stock options of $0.9 million, partially offset by proceeds from exercise of stock options of $0.2 million.
Summary
Future capital requirements depend upon numerous factors, including market acceptance of the Company’s products, the timing and rate of expansion of business, acquisitions, joint ventures, and other factors. IS&S has experienced increases in expenditures since its inception and anticipates that expenditures will remain relatively constant with the levels experienced in fiscal 2021 and fiscal 2020. The Company believes that its cash and cash equivalents will provide sufficient capital to fund operations for at least the next twelve months. Further, IS&S may need to develop and introduce new or enhanced products, to respond to competitive pressures, to invest in or acquire businesses or technologies, or to respond to unanticipated requirements or developments. If insufficient funds are available, the Company may not be able to introduce new products or to compete effectively.
Inflation
IS&S does not believe inflation had a material effect on its financial position or results of operations during the past three years; however, it cannot predict future effects of inflation.
Critical Accounting Policies
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions that affect reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. The Company’s most critical accounting policies are revenue recognition, income taxes and inventory valuation.
Revenue recognition
The Company enters into sales arrangements with customers that, in general, provide for the Company to design, develop, manufacture and deliver large flat-panel display systems, flight information computers, autothrottles and advanced monitoring systems that measure and display critical flight information, including data relative to aircraft separation, airspeed, altitude, and engine and fuel data measurements.
Revenue from Contracts with Customers
In May 2014, the FASB issued Accounting Standards Update (“ASU”) 2014-09, “ Revenue from Contracts with Customers ,” which provides a single, comprehensive revenue recognition model for all contracts with customers, and contains principles to determine the measurement of revenue and timing of when it is recognized. The model supersedes most previous revenue recognition guidance, and also requires enhanced revenue-related disclosures. Under the new standard and its related amendments (collectively known as “ASC 606”), revenue is recognized when a customer obtains control of promised goods or services. The amount of revenue recognized will reflect the consideration that the entity expects to receive in exchange for those goods or services. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.
The Company adopted ASC 606 on October 1, 2018 using the modified retrospective method for all contracts not completed as of the date of adoption. The reported results for fiscal years ended September 30, 2021, September 30, 2020 and September 30, 2019 reflect the application of ASC 606 guidance while the reported results for the fiscal years ended September 30, 2018 and September 30, 2017 were prepared under the guidance of ASC 605, “Revenue Recognition” (“ASC 605”), which is also referred to herein as “legacy GAAP” or the “previous guidance.” The adoption of ASC 606 represents a change in accounting principles. In accordance with ASC 606, revenue is recognized when a customer obtains control of promised goods or services. The amount of revenue recognized reflects the consideration to which the Company expects to be entitled to receive in exchange for these goods or services. To achieve this core principle, the Company applies the following five steps:
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1) Identify the contract with a customer
The Company’s contract with its customers typically is the form of a purchase order issued to the Company by its customers and, to a lesser degree, in the form of a purchase order issued in connection with a formal contract executed with a customer. For the purpose of accounting for revenue under ASC 606, a contract with a customer exists when (i) the Company enters into an enforceable contract with a customer that defines each party’s rights regarding the goods or services to be transferred and identifies the payment terms related to these goods or services, (ii) the contract has commercial substance and, (iii) the Company determines that collection of substantially all consideration for goods or services that are transferred is probable based on the customer’s intent and ability to pay the promised consideration. The Company applies judgment in determining the customer’s ability and intention to pay, which is based on a variety of factors including the customer’s historical payment experience or, in the case of a new customer, published credit and financial information pertaining to the customer.
2) Identify the performance obligations in the contract
Performance obligations promised in a contract are identified based on the goods or services that will be transferred to the customer that are both capable of being distinct, whereby the customer can benefit from the good or service either on its own or together with other resources that are readily available from third parties or from the Company, and are distinct in the context of the contract, whereby the transfer of the goods or services is separately identifiable from other promises in the contract. Most of our revenue is derived from purchases under which we provide a specific product or service and, as a result, there is only one performance obligation. In the event that a contract includes multiple promised goods or services, such as an EDC contract which includes both engineering services and a resulting product shipment, the Company must apply judgment to determine whether promised goods or services are capable of being distinct in the context of the contract. In these cases, the Company considers whether the customer could, on its own, or together with other resources that are readily available from third parties, produce the physical product using only the output resulting from the Company’s completion of engineering services. If the customer cannot produce the physical product, then the promised goods or services are accounted for as a combined performance obligation.
3) Determine the transaction price
The transaction price is determined based on the consideration to which the Company will be entitled in exchange for transferring goods or services to the customer. To the extent the transaction price includes variable consideration, the Company estimates the amount of variable consideration that should be included in the transaction price utilizing either the expected value method or the most likely amount method depending on the nature of the variable consideration. Variable consideration is included in the transaction price if, in the Company’s judgment, it is probable that a significant future reversal of cumulative revenue under the contract will not occur.
4) Allocate the transaction price to performance obligations in the contract
If the contract contains a single performance obligation, the entire transaction price is allocated to the single performance obligation. The Company determines standalone selling price based on the price at which the performance obligation is sold separately. If the standalone selling price is not observable through past transactions, the Company estimates the standalone selling price by taking into account available information such as market conditions as well as the cost of the goods or services and the Company’s normal margins for similar performance obligations.
5) Recognize revenue when or as the Company satisfies a performance obligation
The Company satisfies performance obligations either over time or at a point in time as discussed in further detail below. Revenue is recognized at the time the related performance obligation is satisfied by transferring a promised good or service to a customer.
Revenue from products transferred to customers at a point in time accounted for 100 percent and 97 percent of our revenue for the fiscal years ended September 30, 2021 and 2020, respectively and is typically recognized at the time of shipment of products to the customer. The remaining revenue results from EDC contracts and is recognized over time using an input measure (e.g., costs incurred to date relative to total estimated costs at completion) to measure progress. Contract costs include material, components and third-party avionics purchased from suppliers, direct labor, and overhead costs.
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Contract Balances
Contract assets consist of the right to consideration in exchange for product offerings that we have transferred to a customer under the contract. Contract liabilities primarily relate to consideration received in advance of performance under the contract.
Customer Service Revenue
The Company enters into sales arrangements with customers for the repair or upgrade of its various products that are not under warranty. The Company’s customer service revenue and cost of sales are included in product sales and product cost of sales, respectively, on the accompanying consolidated statements of operations.
Income taxes
Income taxes are recorded in accordance with ASC Topic 740, “ Income Taxes ” (“ASC Topic 740”), which utilizes a balance sheet approach to provide for income taxes. Under this method, the Company recognizes deferred tax assets and liabilities for temporary differences between the financial reporting basis and the tax basis of the Company’s assets, liabilities, and expected benefits of utilizing NOLs and tax credit carry-forwards. The impact on deferred taxes of changes in tax rates and laws, if any, are applied to the years during which temporary differences are expected to be settled, and are reflected in the consolidated financial statements in the period of enactment. At the end of each interim reporting period, the Company prepares an estimate of the annual effective income tax rate and applies that annual effective income tax rate to ordinary year-to-date pre-tax income for the interim period. Specific tax items discrete to a particular quarter are recorded in income tax expense for that quarter. The estimated annual effective tax rate used in providing for income taxes on a year-to-date basis may change in subsequent periods.
Deferred tax assets are reduced by a valuation allowance if, based on the consideration of all available evidence, it is more likely than not that some portion of the deferred tax asset will not be realized. Significant weight is given to evidence that can be verified objectively, and significant management judgment is required in determining any valuation allowance recorded against net deferred tax assets. The Company evaluates deferred income taxes on a quarterly basis to determine if a valuation allowance is required by considering available evidence. Deferred tax assets are recognized when expected future taxable income is sufficient to allow the related tax benefits to reduce taxes that would otherwise be payable. The sources of taxable income that may be available to realize the benefit of deferred tax assets are future reversals of existing taxable temporary differences, future taxable income exclusive of reversing temporary differences and credit carryforwards, taxable income in carry-back years, and tax planning strategies which are both prudent and feasible. For the year ended September 30, 2021, the valuation allowance was released against all federal and state deferred tax assets with the exception of certain state net operating losses due to positive evidence that the assets are more likely than not to be realized in future years. The Company will continue to assess all available evidence during future periods to evaluate any changes to the realization of its deferred tax assets. If the Company were to determine that it would be able to realize additional state deferred tax assets in the future, it would make an adjustment to the valuation allowance which would reduce the provision for income taxes.
The accounting for uncertainty in income taxes requires a more likely than not threshold for financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. The Company records a liability for the difference between the (i) benefit recognized and measured for financial statement purposes and (ii) the tax position taken or expected to be taken on the Company’s tax return. To the extent that the Company’s assessment of such tax positions changes, the change in estimate is recorded in the period in which the determination is made. The Company has elected to record any interest or penalties associated with uncertain tax positions as income tax expense.
The Company files a consolidated U.S. federal income tax return. The Company prepares and files tax returns based on the interpretation of tax laws and regulations, and records estimates based on these judgments and interpretations. In the normal course of business, the tax returns are subject to examination by various taxing authorities. Such examinations may result in future tax and interest assessments by these taxing authorities, and the Company records a liability when it is probable that there will be an assessment. The Company adjusts the estimates periodically as a result of ongoing examinations by and settlements with the various taxing authorities, and changes in tax laws, regulations and precedent. The consolidated tax provision of any given year includes adjustments to prior years’ income tax accruals that are considered appropriate, and any related estimated interest. Management believes that it has made adequate accruals for income taxes. Differences between estimated and actual amounts determined upon ultimate resolution, individually or in the aggregate, are not expected to have a material effect on the Company’s consolidated financial position but could possibly be material to its consolidated results of operations or cash flow of any one period.
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In March 2020, in response to the COVID-19 pandemic, the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) was signed into law to provide emergency assistance to affected individuals, families, and businesses. The CARES Act provides numerous tax provisions and other stimulus measures, including temporary changes regarding the prior and future utilization of NOLs. The CARES Act amends the NOL provisions of the Tax Act, allowing for the carryback of losses arising in tax years beginning before December 31, 2017, to each of the two taxable years preceding the taxable year of loss. Approximately $1,500,000 of pre-tax NOL was carried back two years to fully offset taxable income. This carryback frees up previously utilized R&D credits, resulting in an estimated increase in R&D credit carryforward of $196,000. The carryback created approximately $16,000 of AMT tax, which was refunded. The cash impact of this carryback was $309,412. A receivable was setup for this amount as of March 31, 2020 and the cash has since been received.
In December 2020, the Consolidations Appropriations Act of 2020 (the “CAA”) was enacted as a supplement to the CARES Act legislation providing additional financial relief to taxpayers adversely impacted by restrictions put into place in response to the COVID-19 pandemic. In addition, the CCA provides funding for public health initiatives in response to the pandemic. This legislation did not have a material impact on the Company’s tax position.
In March 2021, the American Rescue Plan Act of 2021 (the “ARPA”), which includes certain business tax provisions, was signed into law. This legislation did not have a material impact on the Company’s tax position.
Inventory valuation
The Company values inventory at the lower of cost (first-in, first-out) or net realizable value. Inventories are written down for estimated obsolescence equal to the difference between inventory cost and estimated net realizable value based on a combination of historical usage and assumptions based on expected usage related to estimated future customer and market demands. The Company’s method of valuing inventory contains uncertainties because the calculation requires management to consider inventory aging, to make assumptions regarding expected usage, and to apply judgments on forecasted future demand, market conditions, and technological obsolescence. If actual future demand or market conditions are less favorable than those projected by management, additional inventory write-down may be required.
New Accounting Pronouncements
In June 2016, FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instrument (“ASU 2016-13”). ASU 2016-13 replaces the incurred loss impairment methodology in current U.S. GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. ASU 2016-13 is effective for SEC small business filers for fiscal years beginning after December 15, 2022. Management is currently assessing the impact ASU 2016-13 will have on the Company.
In August 2018, the FASB issued ASU 2018-13, “ Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement ,” (“ASU 2018-13”) which modifies the disclosures on fair value measurements by removing the requirement to disclose the amount and reason for transfers between Level 1 and Level 2 of the fair value hierarchy and the policy for timing of such transfers. The ASU expands the disclosure requirements for Level 3 fair value measurements, primarily focused on changes in unrealized gains and losses included in other comprehensive income. We adopted this update effective October 1, 2020. The adoption of this standard did not have a material impact on our condensed consolidated financial statements.
In December 2019, the FASB issued ASU 2019-12, “ Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes ” (“ASU 2019-12”), which simplifies the accounting for income taxes, eliminates certain exceptions within Accounting Standards Codification Topic 740, “Income Taxes” (“ASC 740”), and clarifies certain aspects of ASC 740 to promote consistency among reporting entities. We adopted this update effective October 1, 2021. The adoption of this standard did not have a material impact on our condensed consolidated financial statements or related disclosures.
As new accounting pronouncements are issued, we will adopt those that are applicable.
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Business Segments
The Company operates in one business segment as a systems integrator that designs, develops, manufactures, sells, and services flight guidance and cockpit display systems for OEMs and retrofit applications. Customers include various OEMs, commercial air transport carriers and corporate/general aviation companies, DoD and its commercial contractors, aircraft operators, aircraft modification centers, government agencies, and foreign militaries. The Company currently derives the majority of its revenues from the sale of this equipment and related EDC services. Most of the Company’s sales, operating results and identifiable assets are generated in the United States. In fiscal years 2021, 2020 and 2019 net sales outside the United States amounted to $8.4 million, $9.4 million and $7.5 million, respectively.